The IRS recently issued proposed regulations that address employer opt-out payment arrangements and their effect on plan affordability under the Affordable Care Act’s (ACA’s) employer mandate.1 Under the employer mandate, applicable large employers must generally offer full-time employees coverage that is affordable and meets minimum value requirements.

In an opt-out payment arrangement, the employer offers cash — opt-out payments — to employees who decline to participate in the employer’s health plan. According to the IRS, opt-out payments are the economic equivalent of salary reductions, and forgoing an “unconditional” opt-out payment is economically equivalent to forgoing salary. As such, any opt-out payments must be included in employees’ required contribution amount in determining whether the employer’s health coverage is affordable. The IRS provides an exception, however, for “eligible opt-out arrangements.”

The proposed regulations apply for plan years beginning on or after January 1, 2017, but employers and plan administrators may rely on them immediately. Employers with collective bargaining agreements (CBAs) that require opt-out payments have until the expiration date of the CBA to comply. Comments on the proposed regulations are due by September 6.

Background

IRS Notice 2015-87 (Notice) addressed the interaction between employer opt-out arrangements and affordability calculations under the ACA’s individual and employer mandates. An employer-sponsored plan is considered affordable if the amount the employee must pay for self-only coverage does not exceed a percentage (9.66% for 2016) of his or her household income (or, if using one of the three affordability safe harbors, Form W-2 wages, rate of pay or the federal poverty line for a single individual.)

The Notice explained that, if an employer offers an opt-out payment arrangement, the IRS generally considers the opt-out payment as an additional charge for the health coverage when affordability is calculated. However, the IRS distinguished between “conditional” and “unconditional” opt-out payments. An unconditional opt-out payment is conditioned solely on the employee’s declining to participate in the employer’s health plan, and such an arrangement will increase the employee’s required contribution for health coverage for affordability purposes by the amount of the opt-out payment. The Notice mentioned — but provided little guidance on — opt-out payments that require an employee to satisfy additional conditions, such as providing proof of coverage through a spouse’s employer or elsewhere.

For purposes of the employer mandate and ACA information reporting, the Notice provided relief from this affordability issue for periods after December 16, 2015, for unconditional opt-out arrangements adopted before that date. An opt-out arrangement was treated as adopted before December 16, 2015, if one of three conditions was met:

  • The employer offered the opt-out arrangement (or a substantially similar opt-out arrangement) for health coverage provided for a plan year including December 16, 2015.
  • A board or similar body, or an authorized officer of the employer specifically adopted the opt-out arrangement before December 16, 2015.
  • The employer had provided written communications to employees on or before December 16, 2015, indicating that the opt-out arrangement would be offered at some future date.

Those employers eligible for relief were not required to treat the opt-out payment as increasing the employee’s required contribution for affordability calculations under the employer mandate.

Eligible opt-out arrangements

Because forgoing an unconditional opt-out payment is economically equivalent to forgoing salary under a salary reduction election, and because the employee’s required contribution must include any salary reduction amount, the proposed regulations adopt the approach described in Notice 2015-87. Thus, an opt-out payment offered under an unconditional opt-out arrangement generally increases the employee’s required contribution for purposes of determining the affordability of the related employer coverage, regardless of whether the employee enrolls in the employer-sponsored plan or doesn’t enroll and takes the payment. Moreover, the proposed regulations make no exception for de minimis unconditional opt-out payments.

However, the proposed regulations provide an exception for opt-out payments made under an “eligible opt-out arrangement.” To be considered an eligible opt-out arrangement, the opt-out payment must be conditioned on meeting two requirements:

  1. The employee declines to enroll in the employer-sponsored coverage.
  2. The employee provides, at least annually, reasonable evidence that the employee and his or her “tax family” (all those for whom the employee reasonably expects to claim a personal exemption) will have minimum essential coverage (MEC) that was not obtained in the individual market during the period of the opt-out arrangement.

For example, if an employee’s expected tax family consists of the employee, spouse and two children, the employee would have to provide reasonable evidence that all four of them will have coverage under the spouse’s employer plan for the applicable period.

While the proposed regulations do not address any other opt-out conditions, the IRS invites comments on whether opt-out payments could be made subject to other conditions, whether further guidance should address those conditions and, if so, how.

Proof of alternative coverage

Under the proposed regulations, a participating employee must offer “reasonable evidence” of alternative coverage, which might simply be an attestation that the employee and his or her expected tax family have or will have acceptable MEC. In addition, an eligible opt-out arrangement must provide that no opt-out payment will be made if the employer knows or has reason to know that the employee or a tax family member will not have required alternative coverage.

In an eligible opt-out arrangement, evidence of coverage must be provided at least every plan year for the applicable period, and may not be provided any earlier than a reasonable period before the coverage begins. Obtaining an attestation during the regular annual open enrollment period that occurs within a few months before the start of the next plan year meets this reasonable period requirement. Alternatively, an eligible opt-out arrangement could require evidence of alternative coverage after the plan year starts, so the employee and family would already have the alternative coverage.

The employer may continue excluding an opt-out payment amount from the employee’s required contribution for the duration of the applicable coverage period, even if the employee’s alternative coverage terminates before the period ends. Moreover, the exclusion may continue regardless of whether the arrangement requires that the opt-out payment be adjusted or terminated due to the loss of coverage, or whether the employee must provide notice of the coverage loss to the employer.

Under the employer mandate, applicable large employers must offer full-time employees an effective opportunity to enroll in employer-sponsored coverage at least once every plan year. The proposed regulations clarify that, if someone declines to enroll in employer-sponsored coverage for a plan year and does not have the opportunity to enroll in subsequent plan years, the employee is treated as lacking an enrollment opportunity, and an employer may be subject to an employer mandate penalty, for all those years.

Transition relief for opt-out payments under CBAs

The proposed regulations clarify and expand upon the transition relief in Notice 2015-87 for opt-out arrangements provided under CBAs. Specifically, an unconditional opt-out arrangement that is required under a CBA in effect before December 16, 2015, will be treated as having been adopted before that date. In addition, employers participating in the CBA need not increase the amount of an employee’s required contribution by amounts made available under such an opt-out arrangement until the later of (1) the beginning of the first plan year beginning after the CBA expires (disregarding any extensions on or after December 16, 2015), or (2) the applicability date of the regulations for opt-out arrangements. This treatment also applies to any successor employer adopting the opt-out arrangement during the CBA period before December 16, 2015 (disregarding any extensions after that).

The IRS is asking for comments on whether other types of agreements should also be exempt, because, for example, the agreement is similar in scope to a CBA, binding on the parties involved for a multiyear period, and subject to a statutory or regulatory regime.

Opt-out arrangement examples

The following examples illustrate how the proposed regulations would apply to different opt-out payment arrangements. In the first three examples, Company ABC offers coverage under an eligible employer-sponsored plan that requires employees to contribute $3,000 for self-only coverage.

Example 1. ABC Company offers $500 to each employee who declines to enroll in the eligible employer-sponsored plan. Because there are no further conditions for receiving the opt-out payment, it is not an eligible opt-out arrangement. The $500 opt-out payment offer increases each employee’s required contribution under ABC Company’s eligible plan from $3,000 to $3,500 for affordability purposes, regardless of whether the employee enrolls in the employer plan or declines to enroll and receives the opt-out payment.

Example 2. Robert works for ABC Company and is married to Mary, who works for DEF Company. To receive a $500 opt-out payment from ABC Company, employees must decline to enroll in the plan and also must provide reasonable evidence during the regular annual open enrollment period that they (and any tax family members) will be enrolled in acceptable MEC for the next plan year. Robert declines to enroll in the plan and provides ABC Company with reasonable evidence that he and Mary will obtain MEC from DEF’s employer-sponsored plan. Because this constitutes an eligible opt-out arrangement, the $500 opt-out payment to Robert does not increase his required contribution, which remains $3,000 for self-only coverage under ABC’s eligible employer-sponsored plan.

Example 3. John, an employee of ABC Company, is married to Susan, an employee at DEF Company, and he expects to claim their two children as dependents for the upcoming taxable year. During the regular annual open enrollment period, John declines coverage under ABC Company’s eligible employer-sponsored plan and provides reasonable evidence that he and Susan will be enrolled in DEF Company’s group health plan, which is MEC. However, John does not provide reasonable evidence that his two children will have MEC, so ABC Company determines that John is ineligible for the opt-out payment. Because the $500 opt-out payment is offered under an eligible opt-out arrangement, it does not increase John's required contribution amount under the plan, which remains $3,000.

Example 4. William is married and employed by GHI Company, which offers an eligible employer-sponsored plan that requires a $2,000 contribution for self-only coverage. The company offers $300 to employees who both decline to enroll in the employer-sponsored plan and provide reasonable evidence that they will be enrolled in MEC through another source. The opt-out arrangement does not require evidence that family members have other coverage. Because the $300 payment does not require reasonable evidence that William and his family will have MEC, the offer does not constitute an eligible opt-out arrangement. Thus, William's required contribution for self-only coverage under the employer’s group health plan rises from $2,000 to $2,300.

Going forward

Employers with opt-out arrangements should review the proposed regulations and be ready to adopt any changes by the effective date of the final regulations. For those with CBAs that require opt-out payments, the proposed regulations will apply on the CBA’s expiration date.


Endnote

1. This issue was first raised by Treasury and the IRS, as well as the Departments of Labor and Health and Human Services in Notice 2015-87, which was issued December 16, 2015.